Usefulness of the article: This article examines the arguments put forward to legitimize policies for relocating production processes in advanced countries in light of their potential economic consequences.
Summary:
• The COVID-19 crisis has highlighted the vulnerabilities to which companies expose themselves by fragmenting their production processes across several countries and has fueled an already long-standing debate about the need to relocate production processes.
• However, relocating value chains does not seem to improve their resilience to shocks.
• Relocalization would entail significant economic costs for the countries that undertake it, measured in particular in terms of increased prices for consumer products and therefore a reduction in real wages for French workers.
Over the past 30 years, there has been a dramatic increase in trade in intermediate goods between countries. This is linked in particular to the international fragmentation of production processes, which allows companies to benefit from the comparative advantages of their partners in other countries for specific stages in the production process of a good. This phenomenon has generated much debate in both academic circles and public opinion in advanced countries about the appropriateness of this mode of production organization, with the idea that it potentially contributes to the deindustrialization of these countries. The SARS-CoV-2 pandemic is now fueling this debate, as it highlights the vulnerabilities to which companies, and by extension countries, are exposed as a result of this mode of production, particularly in the event of a negative shock affecting value chains. This mainly concerns disruptions in the supply chains of inputs that are essential for the production of goods, which can completely halt production in certain sectors. The question that arises is therefore whether it would be appropriate to relocate production processes. In this article, we will examine the arguments that could be put forward in favor of relocating value chains, as well as the economic consequences that such a policy would entail.
1. Arguments in favor of relocation
1.1 Relocalization is likely to improve the resilience of production chains
Many arguments are put forward in favor of relocating production processes to advanced countries. Among these is the improvement in the resilience of value chains in the face of negative shocks. Indeed, most production chains today operate on a just-in-time basis, meaning that very little stock is held and component suppliers only produce to order. This organizational model, introduced by Toyota in the 1970s, reduces storage costs and improves production efficiency. However, if one of the companies in a production chain is hit by a shock that prevents it from carrying out its tasks or supplying its components, the entire production chain comes to a standstill due to the lack of inventory.
This type of interruption in the production process was observed during the health crisis, with many countries imposing lockdown measures that prevented their employees from working and therefore prevented companies from fulfilling their orders. This was particularly the case when the Wuhan region in Hubei province in China declared a lockdown, as this province accounted for 10% of Chinese automotive production in 2019 and is home to a large number of automotive parts suppliers, semiconductor factories, and chemical plants. This jeopardized the production of many companies in the automotive sector that depend on components from Hubei, including some French companies based there. More generally, it should be noted, as Jean and Vicard (2020) point out, that in 2018, « nearly 6% of French imports were products for which a single country accounted for more than 50% of global exports, » in this case China in two-thirds of cases. This raises the issue of national autonomy in terms of access to certain goods of strategic importance.
1.2 International fragmentation of production jeopardizes countries’ strategic autonomy
One of the striking facts at the beginning of the health crisis was the global shortage of surgical masks. This led the French government to decree a requisition of surgical masks in order to ease tensions in hospitals. It turns out that one of the main producers of this type of mask was China, which accounted for almost half of the world’s production of these highly strategic goods. In addition to masks, there was also a shortage of reagents needed to perform PCR tests, as well as tensions over the availability of ventilators. In order to ensure, or at least promote, France’s strategic autonomy in relation to these key products, the French government has included in its recovery plan a measure to finance relocations in key sectors identified as « future-oriented, » including healthcare, agri-food, electronics, and chemicals. This is also part of a strategy to revitalize the French industrial fabric.
1.3 Deindustrialization in advanced countries is said to be a consequence of the international fragmentation of production
Deindustrialization is one of the main arguments generally put forward to justify the need for relocation. As shown in Figure 1, France has been experiencing a steady decline in industrial jobs for at least three decades. Similarly, the share of industry in French GDP fell from 22.3% in 1970 to 10% in 2017, according to figures from INSEE and the Directorate-General for Enterprise.
Figure 1: Changes in industrial employment in France since 1970
Source: INSEE
Recent literature, initiated by Autor et al (2013), attributes a central role to international competition from China in the decline of industrial employment in rich countries. Malgouyres (2017), for example, establishes that an increase in exposure to Chinese competition of USD 1,000 per employee results in a 6.2 percentage point reduction in the growth rate of manufacturing employment in France. This phenomenon is linked in particular to the increasingly prominent place that China has occupied in global value chains over the last two decades due to its low production costs. For example, according to WITS data, China accounted for 9.7% of total global imports of intermediate goods in 2018, compared with 2.9% in 1988, a growth resulting from the fact that a large proportion of manufacturers have relocated there over time. Some argue that relocation could put an end to this phenomenon. It was partly on this basis that Donald Trump was elected in 2016. However, it should be noted that this policy would not be without economic costs.
2. The economic consequences of relocation policies
2.1 Relocation implies a reduction in the real wages of economic agents
There is a wealth of economic literature on the quantification of trade gains, particularly those linked to the international fragmentation of production processes. Numerous studies suggest that these gains represent between 25% and 65% of total trade gains, considered as the reduction in a country’s real consumption following a shift to autarky.
For example, Costinot and Rodriguez Clare (2014) estimated that if France decided to switch to autarky in 2008, this would imply a reduction in its real consumption of between 17% and 32%. On this basis, the international fragmentation of production processes therefore brings significant gains. Envisaging a relocation of production processes would therefore mean accepting consequences that are rather detrimental to the well-being of the French population, measured in terms of consumption. It should also be noted, as suggested by Bonadio et al (2020), that this would not necessarily be accompanied by particularly greater resilience to the shock of the pandemic.
2.2 Relocalization does not necessarily imply an improvement in the resilience of value chains
Bonadio et al (2020) studied the impact that the initial shock of the health crisis could have had on the economies of 64 countries under different scenarios, one with trade relations and international fragmentation of the production process and the other without trade relations. They estimated that the average reduction in real GDP linked to prolonged lockdown measures such as those imposed at the start of the health crisis in different countries would have had a significantly more severe impact if there had been no trade relations between them (an additional 1 percentage point reduction in GDP on average in the scenario without trade relations).
This is mainly due to the fact that in the scenario without trade relations or where value chains are relocated, the severity of the lockdown measures imposed by most countries makes them more dependent on the availability of local inputs, which are also affected by the shock. Thus, for our authors, foregoing the trade gains associated with the international fragmentation of production would not necessarily translate into greater resilience for most of the economies considered in the specific context of this pandemic. However, this does not rule out the relevance of measures taken to promote strategic autonomy in certain key sectors such as health or new technologies.
2.3 International fragmentation of production: problem and solution?
The shortage of surgical masks at the start of the pandemic, as well as the reagents needed for PCR tests, is sufficient to justify such measures, even if they are not necessarily optimal from an economic point of view, because it is not simply a matter of economic trade-offs, but of potentially saving lives. That said, it remains true that other solutions can legitimately be considered, such as the creation of strategic stocks. It may also be paradoxical to point out, as Miroudot (2020) does, that the source of this problem, namely the concentration of production of these items mainly in China, was also the solution to the problem. China is one of the few countries with the production capacity to meet global demand quickly and at low cost. This clearly demonstrates that the market forces behind this mode of global production will continue to prevail even after the health crisis is over. This is why strategies aimed at reindustrialization are likely to fail if they are not well defined.
3. Relocalization for reindustrialization: a utopian dream?
The decline in industrial employment in France and many other advanced countries, as highlighted above, can be partly attributed to China’s growing role in global value chains and international competition in general. However, this decline began well before China’s rapid rise, as shown in the graph below. It should be noted that a large part of this decline can also be explained by productivity gains (Demmou, 2010). These gains reduce the demand for labor in the industrial sector, but also change the structure of household demand in favor of the service sector, all of which contributes to deindustrialization. It would therefore be counterproductive to direct public resources toward counteracting a phenomenon that is ultimately logical for certain products, particularly those with low added value. This is all the more true given that accompanying measures would be necessary, such as tariff or non-tariff barriers, in order to compete with low-cost products from other countries. This would also be counterproductive because retaliatory measures could be initiated by partner countries, which would put a stop to the international fragmentation of production and reduce France’s added value in the products exported by these countries.
Reindustrialization or industry support policies can only be meaningful if they improve France’s competitiveness in sectors of the future or strategic importance. If these sectors are not of strategic importance, such as healthcare or agri-food, they must be high value-added sectors such as robotics or mobile technologies, where the race for innovation is still ongoing. The relocation plan recently implemented by the government rightly targets some of these sectors. Paradoxically, this will not necessarily translate into substantially more industrial jobs, as these sectors are highly technology-intensive.
Conclusion
Ultimately, relocation policies are likely to generate significant economic costs, particularly in terms of reducing the consumption opportunities of economic agents. However, they do not necessarily improve the resilience of production chains to shocks, which makes it difficult to justify the economic cost. Nevertheless, for certain sectors considered to be of strategic importance, such as healthcare, or for sectors with a promising future, these policies are entirely feasible.
References
Bonadio, B., Huo, Z., Levchenko, A. A., & Pandalai-Nayar, N. (2020). Global supply chains in the pandemic (No. w27224). National Bureau of Economic Research.
Costinot, A., & Rodríguez-Clare, A. (2014). Trade theory with numbers: Quantifying the consequences of globalization. In Handbook of international economics (Vol. 4, pp. 197-261). Elsevier.
David, H., Dorn, D., & Hanson, G. H. (2013). The China syndrome: Local labor market effects of import competition in the United States. American Economic Review, 103(6), 2121-68.
Demmou, L. (2010). Deindustrialization in France. Les cahiers de la DG Trésor, 1, 1-50.
Jean, S., & Vicard, V. (2020). Relocaliser, réindustrialiser, dans quels buts? (Relocalize, reindustrialize: to what end?). La Lettre du CEPII, (410).
Malgouyres, C. (2017). The impact of Chinese import competition on the local structure of employment and wages: Evidence from France. Journal of Regional Science, 57(3), 411-441.
Miroudot, S. (2020). Reshaping the policy debate on the implications of COVID-19 for global supply chains. Journal of International Business Policy, 1-13.
Njike, A. (2020). Trade in value-added and the welfare gains of international fragmentation.
